Despite the increase in the probability of a cut tonight, Draghi may change his forward guidance while keeping rates unchanged. EUR/USD may rise higher as market may start to price in Fed’s cut later this month.
The ECB’s monetary policy meeting tonight is the biggest news we have for this week. It has been a quiet week with close to no major Forex news being released. The only market-mover was Boris Johnson becoming the UK’s Prime Minister.
The market has been pricing in a rate cut as early as this week to September by 10bps. This will effectively bring the current interest rates, which are already in negative territory, from -0.40% to -0.50%. The odds of a cut tonight increased to 48% after eurozone PMIs yesterday fell short of market estimates. This worrisome trend is leading markets to believe that an earlier cut is justified.
However, we believe that ECB will most likely keep rates unchanged tonight while tweaking its forward guidance to include a September cut and even reintroducing the qualitative easing (QE) programme. This is due to four reasons:
- Cutting rates ahead of Fed could provoke Fed Chairman Powell to push for a more dramatic cut of 50bps instead of 25bps. This will undermine the ECB’s easing through rate cuts and would hurt eurozone exporters.
- Major economic data such as inflation and GDP for June will be announced soon and if these data were to fall short, it could give the ECB more justification for a rate cut in September.
- Implementing a rate cut now could risk only a short-lived effect on euro as members of his governing council may not have sufficient time to organise a backlash.
- Lastly, central banks typically prefer to prepare investors for major changes so as not to create too much volatility in its currency. Thus, the ECB may want to change the forward guidance tonight so as to prepare the market.
All in all, a rate cut from the ECB is inevitable and as much as a rate cut from ECB may not be as effective, it is one of only two methods the ECB can utilitie to loosen its monetary policy, with QE being the second.
We may see a knee-jerk reaction from EUR/USD that sets room for a potential rebound to the upside. This is because if the ECB were to hold rates tonight, market will start to price in a rate cut by Fed next. This will cause the dollar to weaken and in turn, result in EUR/USD to rise.
EUR/USD may rise to 1.1200 price level after tonight as long as the 1.1100 price level is not broken.
Fullerton Markets Research Team
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